Defensive positioning will become increasingly beneficial as volatility increases in the wake of central banks’ withdrawing accommodative policies.
That is according to Pimco's CIO of US core strategies, Scott Mather, who has been strengthening his defensive stance every quarter in 2017.
As of December 2017 the effective duration in the Pimco Total Return Bond fund was 4.05 years, which is shorter than its benchmark the Bloomberg Barclays US Aggregate (GBP Hedged) Index at 5.98.
'If you look at BBBs relative to single As, there is too much compression. That's why we think it makes sense to be defensive and make sure your bets are shorter dated and of higher quality.’
‘The question is where to take high-quality government duration and, in our view, it is still the US five-year part of the yield curve which is the most fairly valued part globally right now.’
Another opportunity Mather explores in his portfolio is mortgage-backed securities, which make up one third of the benchmark.
'We think mortgages in general - both agency and non-agency - are fairly cheap and that compares to the majority of other spread sectors that are at best rich. In fact we added a few more MBS even in comparison to 16 months ago.'
Mather said increasing valuations means there is going to be an unusually high correlation between equity market performance and corporate performance.
It is therefore important to have a handful of themes in the portfolio, Mather said, as his team are on average going to be right with 60% of allocation calls and wrong 40% of the time.
‘There was a number of things this year that added value but it wasn't helpful to be underweight corporates. But we offset it with other things we were doing.'
Diversification has also helped Mather and his team during the sell-off of US treasuries in December 2017, which continued into January this year.
‘In our case being short at the very front of the US yield curve was helpful, while the five year portion was unhelpful. We don't think the sell-off continues at this pace that would be equivalent to saying equities will be up 40% at the end of this year.’